Chapter 12 Capital Budgeting Decisions Payback Period and NPV: Taxes and Straigh
ID: 2582026 • Letter: C
Question
Chapter 12 Capital Budgeting Decisions Payback Period and NPV: Taxes and Straight-Line Depreciation Assume that United Technologies Corporation is evaluating a proposal to change the company's manual design system to a computer-aided design (CAD) system. The proposed system is expected to save 13,500 design hours per year, an operating cost savings of $$5 per hour. The annual cash es penditures of operating the CAD system are estimated to be $300,000. The CAD system requires an initial investment of $750,000. The estimated life of this system is five years with no salvage value. The tax rate is 35 percent, and United Technologies uses straight-line depreciation for tax purposes United Technologies has a cost of capital of 14 percent. Required a. Compute the annual after-tax cash flows related to the CAD project. b. Compute each of the following for the project: L02, 3, 6 P12-31. ted Tochnologies Corporation UTX) MBC 1. Payback period. 2. Net present value.Explanation / Answer
Solution:
a.
Operating cost savings (13,500 hours ´ $55) $742,500
Operating costs of CAD/CAM system (300,000)
Before-tax cash savings 442,500
Income taxes without tax shield at 35 percent (154,875)
Depreciation tax shield [($750,000/5 years) ´ 0.35] 52,500
Relevant annual after-tax cash flows $340,125
b.
1. Initial investment / Annual operating cost savings = Payback period
$750,000 / $340,125 = 2.205 years
2. Present value of after-tax cash flows ($340,125 ´ 3.433) $1,167,677
Initial investment (750,000)
Net present value $417,677
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